Working Capital Management Overview
Overview of Chapter Topics
Operating Cash Flows: Review of cash inflows and outflows, including concentration accounts and funding flows.
Cash Flow Timeline and Float: Examination of the cash flow timeline and the impact of float on cash management.
Cash Conversion Cycle (CCC): Analyzing the CCC and its components.
Current Balance Sheet Accounts: Exploring how changes in balance sheet accounts affect external financing.
Working Capital Investment and Financing Strategies: Strategies for managing working capital effectively.
Management of Credit and Accounts Receivable (A/R): Policies and best practices for managing A/R and trade credit.
Management of Inventory: Techniques for efficient inventory management.
Management of Accounts Payable (A/P): Systems for managing A/P effectively.
Multinational Working Capital Management Tools: Tools for managing working capital in multinational companies.
Operating Cash Flows
Cash Inflows:
Concentration Account: A mechanism for pooling cash inflows from various sources to maximize liquidity.
Concentration Flows: Ways to centralize cash inflows to enhance liquidity management.
Cash Outflows:
Methods for tracking and managing short-term investments and borrowing.
Importance of liquidity management in controlling cash outflows.
Float
Definition: Float refers to the time interval or delay between the initiation and completion of specific phases in the cash flow timeline.
Causes of Float:
Wait Time: Time lost while awaiting actions from other parties.
Information Transmission: Time required for inflow or outflow of information.
Process Inefficiencies: Delays related to paper processes and delivery systems.
Float Timeline
Key stages in the cash flow process include:
Order Preparation
Shipping Preparation
Invoice Processing
Typical Delays:
Invoicing Float: 40+ days.
Payment Float: 10+ days.
Disbursement/Collection Float: 1-5 days.
The Cash Conversion Cycle (CCC)
Definition: The CCC measures the time duration between outlaying cash for raw material and receiving cash from product sales.
Illustration: A timeline may show different stages from purchase of materials to collection of accounts receivable.
Formula for CCC:
More on Cash Conversion Cycle (CCC)
Cash Turnover Ratio: Calculated using
Example 1: With CCC = 50 days, Cash Turnover = 7.3 times.
Example 2: With CCC = 39 days, Cash Turnover = 9.4 times.
Problems in Managing CCC
Challenges Include:
Potential lost sales due to inventory shortfalls.
Production stoppages stemming from cash flow mismanagement.
Stretched accounts payable impacting payment policies.
Lost cost-saving trade discounts.
Higher prices from vendors due to inadequate order volumes or slow payments.
Refusal from suppliers to sell to financially weaker clients.
Changes in Current Accounts Impacting External Financing
Changes in Current Assets:
May necessitate additional financing for operations.
Changes in Current Liabilities:
Some liabilities can be spontaneous and adjust with business needs.
External Financing Requirements:
Defined as the changes in Net Working Capital (NWC), calculated as
Working Capital Investment and Financing Strategies
Asset Breakdown:
Fixed assets vs. fluctuations in current assets.
Maturity Matching: Aligning asset and liability maturities to stabilize finance costs.
Investment Strategies:
Restrictive vs. Relaxed Current Asset Investment strategies.
Financing Strategies:
Utilizing both short-term and long-term funding sources effectively.
Management of Credit and Accounts Receivable (A/R)
Relationship Between Treasury and Credit Management:
Credit managers set standards for credit policies, define sales terms, and monitor credit limits.
A/R Management Responsibility:
Billing, processing payments, and managing delinquent accounts.
Trade Credit Policies
Importance of maintaining:
Written credit policies to ensure clarity and fairness, encompassing:
Credit standards, terms, and discounts.
Methods for monitoring customer financial health and collection policies.
The Five C’s of Credit
Character: Willingness to pay, as indicated by payment history.
Capacity: Financial resources available to meet obligations.
Capital: Financial resources that supplement cash flows.
Collateral: Assets available to secure unpaid obligations.
Conditions: Overall economic environment affecting the buyer and seller.
Credit & Payment Application
Forms of Credit Extension:
Different types include:
Open account, Installment credit, Revolving credit, and Letter of Credit (L/C).
A/R Management Objectives:
Convert A/R into cash expeditiously while minimizing collection expenses and losses.
Common Terms of Sale
Various terms include:
Cash before delivery (CBD), Cash on delivery (COD).
Cash terms, Net terms, Discount terms, Monthly billing, Draft/Bill of lading, Seasonal dating, and Consignment.
Management of Inventory
Inventory Management Techniques:
Just-In-Time (JIT) inventory management.
Material Planning System (MPS).
Supplier-managed replenishment programs.
Paid-on-production inventory processes.
Financing Alternatives for Inventory:
Use of trade credit, supply chain financing, collateralized loans, public warehousing, and floor planning.
Management of Accounts Payable (A/P)
Primary Responsibilities:
Verification of invoices and payment authorization (known as “vouchering”).
Disbursement System:
Differences between centralized and decentralized systems of management.
Management Working Capital Management Tools
Tools for managing working capital, especially for multinational operations include:
Multicurrency Accounts: Accounts that handle various currencies for payments.
Netting Systems: For reducing FX transaction costs.
Leading and Lagging Strategies: For effective cash flow management.
Re-invoicing: Center that facilitates international trade between subsidiaries.
Internal Factoring and In-House Banking: To optimize cash flows.
Export Financing: For supporting international trade activities.
Multicurrency Accounts
Definition: Accounts allowing transactions in multiple currencies.
Key Stipulations:
Base currency of the account.
Accepted portfolio of currencies.
Spread or margin for currency exchanges.
Value dates for transactions.
Benefits/Costs of Netting System
Benefits:
Reduces FX transactions and wire transfers.
Provides favorable FX rates & cash forecasting.
Costs:
Setup and maintenance of the system.
Re-invoicing Center Purpose
Manages the purchase of goods from exporting subsidiaries and their resale to importing subsidiaries.
Benefits of In-House Banking
Advantages include:
Reduction in general banking costs through consolidation.
Tax benefits and improved treasury management.
Aggregation of small transactions into larger ones.
Export Financing
Support Structures: Governments assist exports through loans and guarantees via Export Credit Agencies (ECA).
Advantages:
Generally lower fixed interest rates and risk protection.
Disadvantages:
Time-consuming approval processes and currency exposure risks.
What did we learn in this session?
Comprehensive insights into managing working capital, including cash flows, credit management, inventory, and multinational challenges.
Forms of Credit Extension:
Open Account: A form of credit where goods are shipped and the buyer pays later, often within a specified period.
Installment Credit: A type of credit where payments are made in regular intervals until the total amount is paid off.
Revolving Credit: A credit arrangement that allows the borrower to use funds up to a limit, repay it, and borrow again.
Letter of Credit (L/C): A document from a bank guaranteeing payments to a seller upon fulfillment of specified conditions.
A/R Management Objectives:
Convert A/R into cash expeditiously while minimizing collection expenses and losses.
Implement clear follow-up procedures for overdue accounts.
Utilize technology for monitoring and managing receivables effectively.